The Canadian Investor - Berkshire’s recent moves and back to the basic with ratios

Episode Date: August 21, 2020

In this episode of the Canadian Investor Podcast, we discuss the recent movement in Berkshire Hathaway investment portfolio. We then talk about some of our own recent stock purchases. We finish the episode by discussing some commonly used metrics and ratios when investing in the stock market.Tickers of stocks discussed : LVGO, ENGH.TO, OTEX.TO, WFC, BAC, JPM, WSP.TO, DLR, ABX.TO, STOR, AMZN, AAPL, BRK-B--- Send in a voice message: https://anchor.fm/the-canadian-investor/messageSee omnystudio.com/listener for privacy information.

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I'm Brayden Dennis, joined by my co-host Simon Belanger. Simon, how you doing, man? I'm good. Excited to get started. We have lots to talk about today. Stealing most of the headlines is the Oracle of Omaha himself. Warren Buffett's 13F came out. And for those who don't know, 13F is basically a regulatory filing for large asset managers to file what they're doing, what moves they're making with public securities every quarter.

So that's a 13F. And people are obviously very interested in when Buffett's comes out. Last time it was he's selling all the airlines. And this time it was honestly more surprising to me than him being a seller of airlines because even in Q2, Buffett was still a net seller of stocks. What was your main takeaways? Obviously, Simon, the shocking offloading of a lot of bank stocks. Yeah, I mean, I'm'm not i don't know it's hard to be surprised by

it especially because one of those big holdings that he was selling off was wells fargo and if some of you have been following a little bit in the news but also um you know when earnings come out wells fargo has just been a uh a disaster for the past like three years there's been three, four years, I think, there's been scandals. There's been the restrictions placed on them. In the U.S., they actually have regulatory bodies that will tell the banks how much they can pay in dividends and buy back shares. So it's been a really hard time for Wells Fargo. And Berkshire has been a pretty big holder in terms of percentage. I think they've always been close to 10%, which triggers, if you go over that, some regulatory filings and more complications.

And Buffett has always kind of defended Wells Fargo. But banks as a whole, I mean, I'm not overly surprised, mainly because the environment going forward, it gets difficult for banks to make a lot of money, especially when interest rates go down because the spread between the money that they, the interest that they collect and that they lend out tends to get smaller. So less profit margin on that. So I'm not surprised from that perspective. How about you? Yeah, I mean, I get it.

The low interest rates rates not the best situation for banks um but he did then more recently add to bank of america i was not surprised at the wells fargo trim uh i think that was coming that was coming uh regardless uh wells fargo has been you know not the most honest of banks so you know and the company has struggled it's been a crappy culture it's just in retail and they don't uh they don't have a lot of the capital market segments that a lot of the other banks do um you know the premium in that class is probably JP Morgan when it comes to American banks. And they have had that backbone of capital markets, along with some of the other banks as well. So it's interesting to see how that plays out.

You know, they put these massive loan loss provisions same same story here in canada uh with the banks and then hopefully they come around and say it's not that bad and they throw that back into the earnings in the following quarter um so that's kind of the main thing but perhaps the most surprising of all is his new not massive i think it's pretty small it's only 600 million i believe of his new per position in barrack gold which is actually toronto-based gold miner and uh i think the headlines came out big on like fin twitter and you know the other news outlets. Gets a lot of headlines because the New York Stock Exchange ticker for bear gold is gold. Lucky for them.

And, oh, Buffett buys gold. Who's been, if you listen to our gold episode, Buffett has been a perennial bear on gold. And he has other guys working for him, so you don't know if it's a Buffett trade or whatever but at least it's a minor I mean I don't think Buffett would go out and go buy a sizable amount of gold he's been very very vocal about how he thinks gold does nothing for you it It just sits there. It's just pretty,

it doesn't do anything. It doesn't provide income. He's been saying that for decades. So a lot of people are coming out and saying like, what's going on? Like, you know, what is going on over there at Berkshire?

And I mean, who's to say if it was his buy, it's very small position in the grand scheme of things, the amount of cash that Berkshire has sitting on its balance sheet. But I was still surprised to see this position. At least it's a minor. What was your thoughts when you saw, you know, the Oracle buying Barrick Gold? Yeah, a little surprised at the beginning, but the more I thought about it,

the more I'm not overly surprised is because Buffett has shown that he's not afraid to get into commodities in general in terms of businesses. And it's important to, I think, for people to differentiate that he's buying a gold company. He's also buying an established gold company. Barrick Gold is one of the bigger worldwide players. I'm not extremely familiar with them, but my understanding is they have a pretty low cost on an ounce of gold. They have a lot of gold reserves and they do pay a dividend as well. So there is, you know, there is some reasoning behind it. And Buffett has shown that he's not afraid to invest in oil for example so um yeah if you think a little bit about it i don't think it's overly surprising i mean it's a very small take a stake i mean it's you know it's just a drop in the bucket when it comes to

total investment for um for berkshire i don't own any berkshire Hathaway stock. I've never actually have never been a shareholder. No offense to Warren and Charlie Munger. But it seems like this huge basket of cash has just been such a drag for them. You know, everyone was kind of waiting for buffett to make some massive move and then we had the huge market correction uh in q1 and now in q2 there's this rebound uh and into q3 everything's gravy but it's like i'm i am surprised that he is still a net seller. He is the perennial optimist. So I got to say, I never would ever dare bet against Warren Buffett,

the greatest investor of all time. But at the same time, I'd be lying if I said i wasn't very surprised and and if i was a shareholder i'd be a little bit frustrated i would i would definitely be frustrated that he's still sitting on that obscene basket of cash and just waiting for something to happen that you know it happened and you didn't do anything so i mean who's to say we could he could get the last laugh if there's another massive drop um and he capitalizes i wouldn't be surprised by that at all i mean in his defense he's uh you know people were saying that in the early 2000 late 1990s as well about buffett and it might take a decade until he's proven right like Like, who knows? But, yeah, I'm like you.

Some of the moves are a bit head-scratcher for me. I hope Warren is able to do that in a decade. The guy will be 100. I'm not betting against him for hitting 100, that's for sure. All those Coca-Colas he drinks for breakfast, it's got to be doing something for him. He seems to be doing something for him uh he seems to be as wise as ever anyway so that's the uh that's the scoop on what uh what buffett's been buying

what have you been buying simon uh well there's uh so in the past couple months i haven't bought a whole lot i bought three stocks so some of them that I actually talked on the podcast about. So you won't be surprised. I bought some DLR, some digital realty trusts, started a position that after I talked about it, started a position in Livongo actually last week when the price dropped after the merger. I think I mentioned it on the podcast. I just, I kind of, I like the business and I want to have a part of it if the merger doesn't go through with Teladoc. So I started a small position. Is there some arbitrage there as well? Yeah, I mean, there is a little bit, so it hasn't been completely in lockstep so the vongo I think has been trading a little

cheaper than the actual agreement if you compare the like the price of tell a dog the percentage and then the added dollar value it's been pretty close but again there's always some uncertainty there in terms of whether it'll be approved or not and that those are things that do happen but i started a small position in them and i started a position in store capital group i don't know if you're familiar with them oh that was another one buffett bought we missed that one yeah yeah he did buy store exactly and after i heard that i dug into it and there's a lot to like so it is a retail business they do vet all their their tenants and they actually look at their financial statements to

make sure that they are in good financial situation for the most part they do have single tenant operation which means during they're not paying for like the tenants are paying for pretty much everything on top of the rents or property taxes, maintenance and a bunch of other things. So very good cost certainty. They have high quality of tenants, not too many retail sectors that were too badly affected by the pandemic. They have a little bit in like movie theaters and a few other things that have been affected but it's just a very small portion and it pays a really nice dividend and it's been beaten down and kind of included in the

retail REITs in general but they have a lot of essential businesses so if there's any you know if there's another shutdown for example most of their tenants would be able to remain open. So that's the reason why I started a position in them. Fair enough, man. I haven't looked deep into store, but from what I get is that the long-term leases works out for them. And it's definitely a predictable cash flow generator. Yeah, makes sense to me. I know you like DLR, so I'm not surprised that you're adding to that position. As do-it-yourself investors, we want to keep our fees low. That's

why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense, and with them, Questrade is Canada's number one rated online broker by MoneySense. And with them, you can buy all North American ETFs, not just a few select ones, all commission free, so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award-winning customer service team with real people that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service. Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit questrade.com for details. That is questrade.com.

That is questtrade.com. go on there, I am shocked. The engagement is amazing. This is a really vibrant community that they're building. And people share their portfolios, their trades, their investment ideas in real time. And it's all built on the concept of transparency because brokerage accounts are linked. And then once you link your brokerage account, you can get in-depth portfolio insights, track your dividends, and there's other stuff like learning Duolingo style education lessons that are completely free. You can search up Blossom Social in the app store and join the community today. I'm on there. I encourage you go on there and follow me, search me up. Some of the YouTubers and influencers and podcasters that you might know, I bet you they're already on there. People are just on there talking, sharing their investment ideas

and using the analytics tools. So go ahead, Blossom Social in the app store and I'll see on there. People are just on there talking, sharing their investment ideas and using the analytics tools. So go ahead, blossom social in the app store and I'll see you there. For me, I am buying infrastructure and tech for the most part. I'm not surprised. Yeah, I mean, I'm okay with disclosing some of this stuff because it is late in the month already at the 19th. And my subscribers get it on the first Tuesday of every month. Brookfield Asset Management and WSP Global, as well as TFII, which has been a absolute huge winner when I was buying it back in March.

Everyone was worried that logistics was going to get crushed. And I thought TFII was massively, massively oversold. And they continued to make acquisitions all through the pandemic. So they're showing some resiliency there as well. WSP, I love because it's a global take on infrastructure services, which means it's really capital light. They're a Canadian-based engineering firm, but they do business all over the world. And they've been making some really strategic acquisitions as well um you know why i like bam i mean seriously come on um and then

the two software as a service acquirers that i i will continue to be buying even if they're richly valued which is open text and enchouse those are some of the best you know technology plays in canada in my opinion um and uh yeah they've performed exceptional so open text for instance like the recurring revenue is so strong with really really high quality clients and they're in the right space it's uh it's cyber security uh cloud as a service and not only do those things have massive tailwinds but they have some really really big big clients and really really sticky software uh and on an enterprise level so i've been buying open text for as long as i've been investing and I would continue to own it here. It's not like the explosive SaaS growth that a lot of people are looking for, but it is solid as a rock when it comes to that recurring revenue and the tailwinds behind them so if you don't own open text or have never heard of it it's about a you know

just under 20 billion in market cap company out of waterloo ontario they actually had a really cool story it was started from professors at waterloo university and they're the name open text they were trying to digitize the oxford dictionary as i understand it and this they clearly went down some massive entrepreneurial rabbit hole uh once they started on that project so it is a quite quite a cool story local here ontario and waterloo so if you don't know the company the ticker is otex and it's listed both uh in canada and in theloo. So if you don't know the company, the ticker is O-Tex and it's listed both in Canada and in the US. Simon, let's talk about, we're going back to basics a little bit here on this episode. We're going to talk about a whole bunch of ratios, some rule of thumbs. Some of them are quite elementary. So if you're an experienced investor, you're going, I know what that is.

That's fine. There's a lot of people here that don't. And there's a lot of people that maybe earlier in your investing journey, you would have appreciated this information. And I know I would have if I was a 101. So let's get right into it. Priced earnings, obviously, is a ratio that is price divided by earnings. So this is price, the share price divided by earnings per share. And this is a real indicator of valuation on many businesses. And it's probably, well, not probably, it is definitely the most used quick valuation metric. I think that it's completely misused, but it's a very good

first glance to get an idea of what you're talking about. So when a company's trading at 50 times earnings, my brain thinks, okay, this must be a high, very high growth business because that's expensive. If it's trading at, you know, 15 times earnings or less, I'm thinking, okay, this is probably an established slow grower, dividend payer, or the market hates it, one of the two. So anywhere in between, it really depends, but it's not useful unless we're talking about several other factors. So I think that's the main thing we want to harp not useful unless we're talking about several other factors. So I think that's the main thing we want to harp on is when we're talking about these ratios is almost none of them are useful completely on their own, but they're very useful in combination with each other to get a full picture of what you're dealing with. So P.E., Simon, what is a typical rule of thumb of high versus low when you see price-to-earnings ratios? Yeah, I mean, it'll depend on the type of business that it is.

It could be anywhere. Like, you'll see low, so you'll see a lot of price-to-earning ratios, especially for banks. And by the way, we've had a lot of questions to earning ratios, especially for banks. And by the way, we've had a lot of questions about Canadian banks, and we will try to do that on an episode in the next month or two. I will have to do a bit more research, just a side note. But you'll actually see banks that will have, for banks, you'll see like high single digits, low double digits in terms of price to earnings. Other types of business, you'll see something a

bit more in the high teens, in the 20s. Anything above 30, I would say, starts being expensive. But again, it all depends on the sector. It depends on the business. You should not use price to earning. And I've said that before like it's completely useless if you're looking at like a real estate investment trust so the price to earnings will make it'll be all out of whack it won't make sense and that's because we've talked about it before earnings there's depreciation and amortization and that's actually not a not it's a non-cash item so it's very misleading for those type of businesses even businesses like Brookfield Renewable Partners or Brookfield Infrastructure Partners. They're not very useful for those type of businesses.

So that's kind of my take. It is a good metric, but it has its limitations. It's completely useless to if the company is not making money yet. Yeah, totally. If the company's not making money yet, it's not applicable. Yeah, exactly. There's no denominator. And if you were an only specific type of PE investor,

you would have missed Amazon the whole time because they didn't want to show profits for taxation purposes. And you'd be someone like myself ignoring Amazon because they don't make any profits. So again, it's a very useful metric. It's very important to understand the types of industries and rule of thumbs that exist in it. But again, it cannot be used in a silo. Yeah, exactly. And for tech companies i know you like those like especially tech companies where the reinvestment in the business and technology and all that it is you'll find those investment in the earning statement right so those companies that yeah if they didn't reinvest they could be like pumping out money left and

right well because they're reinvesting and Amazon's a great example, you think it's less profitable than it is. So that's why I mean, it is a metric that can be useful, but I find that a lot of people use it incorrectly. And we've had questions about people saying like, oh, this REIT is a PE of this. And that goes back to my previous point. It's just, it gets thrown out there a lot. That's just my opinion on it. Yeah, like SNC-Lavalin is like a 2 PE today. Oh my God. All right, moving on. What do you got next for us? Okay, so next is dividend yield. Dividend yield, what is dividend yield dividend yield what is dividend yields pretty simple you take the the total dividend paid in a year and then you divide it by the current stock price

something i like to go on and i know braden you like as well is your yield on cost so it's the same calculation but then you look basically if you're three four years in the future from then and then you calculate what you're currently receiving for a dividend based on your original cost. It is useful. I would say don't get mesmerized by the yield double digit or anything like that. If you see some high dividend yields, just make sure you do your due diligence. And it doesn't have to be double digit necessarily um for example brayden i'll ask you like what would be your first

kind of take if you saw a tech company with a five percent dividend yield um what on earth is going on this would be my first question uh and second it would be oh this this tech company software company pays a small dividend but uh the share price just went through the floor something really bad happened and now it looks like there's a juicy dividend yield on it but it's probably not safe yeah and if i if I ask you the same question, there's an infrastructure company that's paying a 5% dividend yield. What's your reaction with that? It's that makes complete sense. So it's difficult, right? There are these rules of thumbs. And when it comes to stability of the company and, and what growth trajectory it's on, if you have a really, really high growth company, you don't want them paying out huge percentages

of earnings out to the dividend. Exactly. And did you have anything else for the dividend on the rules of thumb for you? I mean, I think we just got it there, right? It depends completely on the company. If it's a bank paying 4%, yeah, perfect. They're probably sustaining that at a 40% payout ratio, which we'll

talk about next. But if I see that on a software company, I'm going, what's going on? They probably don't even have that much earnings. And they're still in a growth phase. So it definitely depends. As soon as I see a company that's with a dividend yield of over 10%, I'm thinking there's something seriously wrong with the business typically. And I'll probably look into the payout ratio. I'll look into if the stock just fell massively and on a trailing basis, that's why it's over 10%. That happens all the time.

And we saw that in March when a lot of oil companies were yielding over 10% because the share price was down so much. It didn't necessarily mean that you should rush to go buy dividend yielders. And Canadians are obsessed with dividends. And I don't know why. I love high yield on cost. But am I going out and buying a bunch of eight yielders, 8% yielders? No, unless it's a real estate investment trust, absolutely not.

So moving on to the payout ratio, which mentioned that a couple of times is what percentage of earnings is going to support those dividend payouts. So if that's over 100%, then that means that they are paying the dividend with earnings that they didn't just collect in that quarter. So if they exceed 100%, they are burning cash reserves to pay the dividend or fueling it with debt, which is not sustainable. So I mean, if it hops over 100%, based on like seasonality, the business has like cyclical seasonality, and they're keeping the dividend, sure, whatever, but it cannot sustain over 100%. So as a rule of thumb, as a dividend growth investor myself, I'm looking for high yield on cost, not current dividend yield. I'm looking for low payout ratios,

because that's going to have lots of room to run. They're going to be able to continue to grow those payouts over time. Yeah, that's well put. I personally prefer when I look at payout ratio to look at it versus free cash flow, just because that gives me a good indicator of the actual cash coming in and out. And if that covers the actual dividend again for the same reasons i talked about the price earnings earlier i find the payout ratio with price earnings can with the as a proportion of earnings sorry can be a bit misleading but i'm totally with you you want to make sure the dividend is sustainable and And in terms of payout ratio, I would say, again, it varies by industry.

Again, if you have a utility that's paying 80%, it's, I mean, oftentimes that'll be fine because they have very stable cash flows coming in. Versus, like you said, something that's a bit more cyclical that would be paying like 90%. That's something that you should be a bit more cyclical, that would be paying like 90%. That's something that you should be a bit more worried about. But just putting things in perspective, that's important. Ditto. What do you got next for us now with return on invested capital? Yeah, so return on invested capital is just, it's very simple in its, you know, it's an in its idea, if you'd like. So return on invested capital, you take all the capital that's invested by the business, whether it's through debt or whether it's new capital coming in with

new share issuance or reinvested earnings. So you just take that and you try to get the return of those investments. So the higher the percentage, the better generally. But again, that's something you'll want to compare with the the actual business itself historically, but its peers as well to see how they're doing. Yeah, completely. And a lot of famous investors have been quoted saying, you know, long term, your returns, if you paid a fair price, should be similar to return on invested capital. And if it's trending down, you could argue that in a way, the company's destroying value over time, which is not ideal. So you want a company that's continuing to reinvest the capital and the cash that they're generating from the business when they're injecting that back in the business.

If there's a high return on them, like internal ROI for them, which is return on invested capital on the cashflow, it's going to return long-term great returns for you if they have sustained high return on invested capital so you see businesses with you know north of 20 30 percent return on invested capital like some of the best businesses in the world and those are really really nice long-term compounders again that's that's a really high number, but they do exist out there. Yeah, well put. So the next one we'll look at is the price to book. So that is one that is used quite a bit still. There's a lot of limitation to price to book. So price to book is basically net assets. So how do you calculate net asset in terms of the book value?

You just take the total asset and you subtract liabilities. And then whatever number you have left would be the book value of the business. And then you just compare the market cap compared to the book value of the business. So typically, that'll be a much better ratio when you look at banks, for example. So financial institution, very useful. Insurance companies as well. Companies that have a lot of like heavy assets. So if you look at even utilities could be useful in terms of price to book. But it's another one that I find like it gets thrown around and for certain type

of businesses it's completely useless and tech is probably one of those whereas a lot of the assets for a tech business is actually intellectual property or intangible assets so you will oftentimes get like a price to book that's all out of whack for uh for those types of companies um yeah that's about my take on it what about you brayden yeah it's very useful in some businesses like you mentioned buffett tries to buy back a bunch of stock when it's trading close to book value makes sense it's an insurance business primarily a A lot of it is anyways. Versus a tech company, if it's priced a tangible book, there's basically, they're very, very asset light. So that metric's going to look completely outrageous, can be very, very high. But again, their assets are not similar to a manufacturer that has plant property and equipment.

So again, not useful at all. But you summarized that well. Moving on, one of the most important when you're first looking at a company to understand, is this a big business? Is this a small business? Is this a medium a big business? Is this a small business? This is a medium sized business is obviously market cap, or market capitalization, which is share price versus outstanding shares that will give you the total value the stock market is assigning it. And I also want to compare

that to what is also thrown around as enterprise value. And enterprise value is just market cap, and then you add on all their debt, all their liabilities. So the reason why you do that is if enterprise value is the number that a PE firm would look at when they're buying a company, because they're going to also take on all the liabilities. out when they're buying a company because they're going to also take on all the liabilities. So if they have 200 million in debt, they're going to have to service that debt if they buy that corporation. So that's why some people use enterprise value to understand their liabilities as well as the market cap if they were to buy the business outright. If there's a big discrepancy between the market cap and the enterprise value, it probably means or it does mean actually that the company is carrying

a lot of debt. Yeah, well put. I mean, personally, I like to use market cap for not necessarily that I don't like to use enterprise value. But I love just if I'm looking at a business for the first time, I'll just look at the market cap, first of all. And then I'm looking at a business for the first time I'll just look at the market cap first of all and then I'm trying to like as a very first step just to think okay this type of company does ABCD in terms of services or whatever it does there is a current you know five billion dollar market cap in 10 years from now can I realistically expect the company to be 25 billion 30 billion whatever the multiplier is and that'll give me a decent idea of what at least i could potentially expect in terms of growth trajectory for for the business yeah good point um because today today august 19th apple hit two trillion two trillion in market capitalization um which is

absolutely absurd and i would have looked at the company at one trillion when they did and went how can they possibly you know bag again and when i say bag i just mean like multiply and that was a hundred percent ago and not that long. So kudos to Apple. They're definitely crushing it. But so you can think about, is this business really worth that price in a large scale? Because share price means absolutely nothing. And that's why when we tell you stock splits mean nothing, it's because it does not

affect the market cap at all. Although everyone who owns Tesla thinks that it matters. Anyways. You had to put Tesla in there. Yeah, we had to throw it in there. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense. And with them, you can buy all North American ETFs, not just a few select ones, all commission free so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award-winning customer service team with real people that are ready to help

if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service. Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit questrade.com for details. That is questrade.com.

Calling all DIY, do-it-yourself investors. Blossom is an essential app for you. It has been blowing up with now more than 50,000 Canadians plus and growing who are using the app. Every time I go on there, I am shocked. The engagement is amazing. This is a really vibrant community that they're building. And people share their portfolios, their trades, their investment ideas in real time. And it's all built on the concept of transparency because brokerage accounts are linked. And then once you link your brokerage account, you can get in-depth portfolio insights, track your dividends, and there's other stuff like learning Duolingo style education lessons that are completely free.

You can search up Blossom Social in the app store and join the community today. I'm on there. I encourage you go on there and follow me. Search me up. Some of the YouTubers and influencers and podcasters that you might know, I bet you they're already on there. People are just on there talking, sharing their investment ideas and using the analytics tools. So go ahead, blossom social in the App Store and I'll see you there. Tell us about some capital structure metrics.

Okay, so let's go for debt to equity ratio. So that is one that is thrown around. Another one that you guys will hear a lot. Debt to equity, it's pretty simple. You take the total shareholder equity and then you compare it to the debt. Some people will compare it strictly to the debt. Some people would compare it to to the debt some people would compare it strictly to

liabilities as a whole I personally do it a little differently than those I do like when I calculate the equity I tend to like to subtract any goodwill because to me that doesn't provide much value in terms of assets and usually ends up being written down anyways. And then I'll look at it versus total liability. So I like to look at all liabilities, not the debt. It's a good thing to look at. Again, if you're using it, just make sure you're consistent in the way you're using it and you compare the company with itself in the past, but also the company with its peers. And it'll give you a good idea in terms of, okay, like how does it look in the past, but also the company with its peers. And it'll give you a good idea

in terms of, okay, like, how does it look in terms of, you know, is it financially stable? Can they withstand some big tribulation to their business? Or will they have trouble making their interest payments? Or if the debt comes due, having trouble financing that. So it's a good metric for that just to give you an idea of what it is if it's stable financially. Yeah, totally. And ideally, I like that you mentioned it depends on the business because ideally, you don't have companies trading at over one, which would be more debt than equity. But if it's a company like a telco or a power utility that has super, super stable cash flows and requires a lot of capital investment to run the business, that's not surprising or scary. But if it's not a cash flowing machine like those two industries then you might be a little

bit concerned moving on another balance sheet ratio is the current ratio one that everyone and their dog was looking at the start of the pandemic because we thought there was going to be widespread uh bankruptcies and illiquidity which which, you know, there was there's definitely been some and there will be more. But that is just current assets over current liabilities. And current just means for assets, it is cash, or things that can be converted into cash within one year, in generally accepted accounting principles. So it's thought of as cash, or you can at least extract cash out of that within a year. So if that is high, that is good, you have more current assets to service current liabilities, and those liabilities are due within one year. So if there's a really,

really low current ratio, I'm like, what is going on? Why do they have so much high current liabilities and why don't they have any cash on the balance sheet to service that? So I'm definitely doing a deeper dive or walking away from that investment if that's too low. Yeah. I mean, I totally agree with that. I don't think I have much to add for that one. All right. So the next one, so price to sale. Price to sale, we've talked about that a lot.

It's used a whole lot specifically in the tech sector. It's used in other sectors as well, but tech sector is really good because of some of the things we mentioned before. A lot of these companies are not profitable when you look at their actual earnings. Again, some of them are actually cash flow positive, even though they're showing as not profitable to earnings. But because of that, the price to sell will give you a good valuation metric when comparing it to some of its,

let's take tech companies, some of its tech peers. In terms of sales, one of the things we always look at, Brayden and I, and we've mentioned it before, you want to see those sales increase from year to year. That's always a good indicator. You want to also be able to make sure that the increase is sustainable for at least a medium to medium term, but I would say long term. And, you know, a lot of people will do the mistake of projecting those high growth rates very, very long term. Reality is, is oftentimes you can have some high growth rates, and then

you think it's going to continue like that for the foreseeable future. And then bam, you have a deceleration which doesn't mean that it's no longer increasing but it's increasing at a lower rate and what will happen is those stocks will usually have that growth rate priced in so you can get a pretty severe drop if there's even a small slowdown that doesn't look too major so that's it's a really useful metric from that perspective, though. Any comments on that, Brayden? Yeah, price-to-sales ratios in the tech sector

have been absolutely stretched into places I thought they would never go, but here we are. And it's used so often, obviously, in tech, is because, one, a lot of them are fast growing and don't show profits and don't intend on showing profits because they're still getting high turns on invested capital, like very, very high. So they don't have any, there's no PE. So where do you go next? You go price to sales. You also can't use price to book.

So what are you going to use? price of sales. You also can't use price to book. So what are you going to use? So when it comes to venture capital as well, when companies are being bought out on private sales, they're typically bought out on multiples of their sales. So, oh, yep, company X went for seven times revenue or seven times sales, same thing. So that's, that's where that comes from in terms of the multiple of the revenue. And you're seeing very high price of sales right now. But, you know, it is what it is. Some of these companies demand those, those premiums, because they should be trading at those premiums. I have a question for you, you touched on revenue increase. at those premiums.

I have a question for you. You touched on revenue increase. What number, and I have a number in mind, what number do you look at in terms of year over year compound annual growth rate of revenue and think it's the tipping point between a growing business and a fast growing business?

Oh, wow. That's a good question. Yeah, exactly. We did not discuss that full disclosure. I'm taking, I gotta keep you on the toes, man. Just stalling a little bit before I answer. I don't know. I feel for me, it's probably when it slows,

probably double digit. So if it's, you know, 10, 15% is probably the threshold from like, fast growing to extremely fast growing, in my opinion. But again, I think it's a bit arbitrary. So what numbers you have in mind, Braden? It is arbitrary, but you nailed it. I was gonna say the exact same thing. I think anything under 10%, I'm thinking, okay, it's a growing business between, this is assuming it's between zero and 10, that it's a growing business, but not a fast growing business, 10 to 20% year over year. I'm thinking, yeah, this is a fast growing business. And then everything over 20% a year, it's like, yeah, these are, these are really fast growing businesses. If they can sustain

those growth rates, for sure. And on that same note is when it comes to valuation and these tech companies, software as a service, primarily with big revenue growth and very high price-to-sales ratios, potentially, who knows, being stretched too far, you could make that argument, is they all do have something that's pretty common amongst them, which is very, very high margins and very high gross margins. And what that means is it's just the percentage of the

revenue that's trickling down after they pay for like actual product costs or like what people call cost of goods sold. So for a software company that does not have to provide input costs for manufacturing and these kinds of things, they have really, really low cost of goods sold to provide that software as a service. They might have lots of other costs down the lower on the income statement, don't get me wrong. But the actual scalability, once they acquire customers, is really, really nice, because those gross margins are so high. So you're seeing lots of software north of 70 north of 80, even close to 90% gross margins, meaning that you know, the actual product cost is like 10% on a 90% gross margin. So

depending on the industry, you're going to see different gross margins. But if you can see that continually go up, it means one of two things. They have pricing power, so they're able to demand higher prices without the customer getting upset. And that is going to increase the gross margin. Or they're really good at refining their supply chain, refining their process, and getting cost of goods sold down. So I like to see an increase in gross margins. It's one of my favorite metrics to look at to understand what kind of business it is

and how effective they are at turning revenue down the line eventually into free cash flow. But it's going to start with cost of goods sold, and that's going to be reflected in the gross margin. Yeah, I mean, not much to add on that. So I'll go to the next one. Give us the gross margin. Yeah, I mean, not much to add on that. So I'll go to the next one. Yeah, exactly. So the last one, that's one I do like to look at, especially for businesses that have some debt. I mentioned that because there are businesses that have either

very low or no debt. So interest payments, so the amount of their interest payments are compared to their EBITDA. So EBITDA is earnings before interest, taxes, depreciation, and amortization. So the higher that number, the better it is. And again, that's something you want to compare with the business itself in the past and its peers to see how they're doing. But what that really tells you is how much money or how many times they actually cover their interest payments compared to their EBITDA. And it's just a good way to look at it personally that I find just to give me an idea whether they're having trouble

making those interest payments and there could be trouble down the line. If I see that number shrinking a whole lot from year to year, that's some alarm bells. Or if I see that number is really low in terms of EBITDA, sorry, I had to reverse EBITDA compared to interest payments. If I see that number gets lower and lower, there could be a lot of warning signs. So that's just one that I like to keep an eye on to make sure that, you know, the company is not heading towards bankruptcy or anything like that. This is one that I want to start using after you brought it up and haven't previously, because it's a pretty creative way to understand some fundamentals of their balance sheet by actually looking at their

income statement, if I understand it correctly. Yeah, exactly. It just gives you a quick idea of, yeah, like if they can actually make those payments. And it's good to look over an extended period as well, just to get an idea whether it's going up or down. So it's one that I like. You don't have to, you don't need a specific number, but comparing it will give you a good idea whether it's an alarm bell or it's trending the right direction for that company. All right, guys.

We've been blabbing your guys' ear off for the better part of an hour now. I hope you guys find lots of value in this episode. There's lots of, lots of ratios that we could talk about. There's, you know, an infinite amount. You can manipulate it any way you want, but these are some of the ones that I'm always looking at. Simon's always looking at to understand the business on the very, very surface. And these are also really useful metrics to screen on. And then you can really, really do your research. And all of these numbers are quantitative in nature, of course. So then the fun, the art part

of investing comes in is okay, I understand how fast it's growing, I understand some margins, I understand if the you know, the if they pay a dividend, if it's safe or not understand the valuation. But what core to the business, the actual model, the actual business model is the kind of the next understanding that you got to do. And that's what comes down to the the fun part of investing is once you have that statistical understanding, and the quantitative fundamentals of the business, it's growing at x amount, it's valued at this amount. Now you're going to look at the actual moat that the business may have, and hope that there is a moat so that it can fend off competitors, have pricing power and continue to compound long term.

So that's that's round two. But we hope that these numbers will give you an idea and at least the rule of thumb when it comes to investing. to investing. Would you say, Simon, when it comes to coming up with a rule of thumb for these types of numbers that you see across different industries and stuff like that, would you say you picked that all up from just looking at different businesses and actual investing experience? Or did you go to a specific resource for that? Yeah, no, it's definitely just experience and looking at the data, right? So I think that's the most important thing. I've said it before, compare specific businesses to their peers in the same sector or that are very similar, compare it to themselves if they have a long history and look how those ratios look and if they're trending in the right direction. You can also compare it historically versus an index of your choice, whether it's the S&P 500, the S&P TSX, whatever it is.

These are all things that will help you put those numbers in perspective. But our purpose today was just to let you know some of the ones we use, but also the limitations of some of the ratios, as we mentioned. Some of them will be more useful for certain type of businesses than others. Yeah, totally. 100%. All right, guys. That does it for this week. We will see you next week. Again, reminder, go ahead and give us five stars.

Leave us a nice review if you appreciate the content. We appreciate everyone reaching out via email, Twitter. We really appreciate it. But you know what you can also do? Just go leave us five stars, write a nice review. Tell us where you listen to the podcast, why. We appreciate it a lot. We'll see you guys next week.

Bye-bye. The Canadian investor is not to be taken as investment advice. Braden or Simone may own securities mentioned on this podcast. Always make sure to do your own research and due diligence before making investment decisions. advice. Braden or Simon may own securities mentioned on this podcast. Always make sure to do your own research and due diligence before making investment decisions.